APRA have released a discussion paper on Pillar 2 of Basel II – the Supervisory Review Process.

Most of the content has already been well telegraphed ahead, either by the prudential standards already released (particularly APS 110) or in the other discussion papers and speeches. The one real disappointment is the decision to maintain a 10% capital drop “floor ” for the next two years – “…pending a review of experience…”.

The levels of conservatism here are getting frustrating. APRA have already added floors (or is that flaws) into several places, both on a general level (the 20% LGD on housing loans for example) and specifically into many individual ADIs, for example many smaller ADIs have been hit with higher capital levels seemingly in preparation for Basel II.

All of the regulators around the world, and APRA no less than others, have been boosting Basel II as a much better risk management framework than Basel I. I would entirely agree. The new frameworks will make banks generally much safer. Why, then, do they need to keep capital at or near levels that had no justification when they were implemented?

To me, this is akin to a road regulator saying that, despite the improvements in car design, road safety and everything else since the early days of motoring we still need to have a person walking in front with a red flag “as it is just safer that way”. The only difference now is that the guy in front may be a

llowed to run.